Question

Central Bank plans to launch a new deposit campaign next week in hopes of bringing in from $150 million to $650 million in new deposit money, which it expects to invest at a 12.75 percent yield. Management believes that an offer rate on new deposits of 5.75 % would attract $150 million in new deposits and rollover funds. To attract $200 million the bank would probably be forced to offer 6.5%. The bank forecasts suggest that $350 million might be available at 7 %, $400 million at 7.5%, $550 million at 9.5 % and $650 million at 10.5 %. What volume of deposits should the bank try to attract to ensure that marginal cost does not exceed marginal revenue?

Make sure to lable all the colums correctly

Answer 1

Marginal Cost is the cost of borrowing additional funds (i.e. cost of additional deposit from customers). The formula to calculate the marginal cost is = Interest Cost of Additional Deposit / Additional Deposit * 100.

Marginal Revenue is the additional revenue earned from investing the deposits received from customers. As the expected yield (return on investment) is 12.75% at all levels of investment, marginal revenue will be constant at 12.75%.

We will calculate the marginal cost in the following table. That level of deposit where the marginal cost does not exceed the marginal revenue will be the total deposit that Central Bank should try to attract.

1	2	3	4 = 2 * 3	5 = Current row (-) Previous row of column (2)	6 = Current row (-) Previous row of column (3)	7 = 6 / 7 * 100
Sr. No.	Deposit ($ million)	Rate of Deposit (%)	Cost of Funds ($ million)	Additional Deposit ($ million)	Additional Cost ($ million)	Marginal Cost (%)
1	150	5.75	8.625	150 (150 - 0)	8.625 (8.625 - 0)	5.75%
2	200	6.50	13.00	50 (200 - 150)	4.375 (13.00 - 8.625)	8.75%
3	350	7.00	24.50	150 (350 - 150)	11.50 (24.50 - 13.00)	7.67%
4	400	7.50	30.00	50 (400 - 350)	5.50 (30.00 - 24.50)	11.00%
5	550	9.50	52.25	150 (550 - 400)	22.25 (52.25 - 30)	14.83%
6	650	10.50	68.25	100 (650 - 550)	16 (68.25 - 52.25)	16.00%

The Marginal Cost is below Marginal Revenue till $ 400 million of deposit. At $ 550 million of deposit and above, the cost of getting the additional deposit i.e. marginal cost (14.83% & 16%) exceeds the yield on investment (12.75%).

Hence, the Central Bank should try to attract $ 400 million of deposit from customers.